How Long Will this Housing Shortage Last?
Home prices have risen at a double-digit rate since early spring. The Case-Shiller reading was up 11 percent in March compared to a year earlier, while the NAR median price was higher by roughly the same amount in April. This robust appreciation appears nearly certain to last for the remainder of 2013 and the reason is basic economics: increasing demand and tight supply.
Data on pending contracts and closed sales are at five-year highs, while data on homebuyer traffic activity (an element of the REALTORS® Confidence Index) is almost moving off the charts. Multiple bids are increasingly common in many local markets. With so few homes on the market – as evidenced by a 13-year low inventory of existing home listings and a 50-year low for newly constructed home inventory – buyers are increasingly forced to bid with an escalation clause in hopes of winning a home.
The rise in housing demand in conjunction with the improving economy is not surprising. It was bound to happen after an unprecedented five consecutive years of deeply suppressed household formation – less than half the normal rate at 500,000 new households per year from 2007 to 2011. But the renewal of household formation in 2012 and 2013 induced by six million net new job additions since early 2010 has rejuvenated demand for home purchases and rentals. The rebound in household formation will likely continue for several years, perhaps averaging 1.2 to 1.3 million per year over the next five years. Even if that growth is not realized, a return to the historic average of 1 to 1.1 million additions per year implies healthy future demand for home buying and renting.
But where is the supply to meet this new demand? First, the logic that rising prices will unlock underwater homeowners who will add to supplies of for-sale homes does not have merit. Yes, they may list their home for sale, but the intent is to move and buy another home, and not to sell to become a renter. The result is a net wash for inventory.

In a few cases, “accidental landlords” may provide additional supply. This concept refers to an underwater homeowner who needed to move, but could not sell her original home, opting to rent it in order to cover the mortgage payments and other costs. Some of these accidental landlords will choose to sell when price growth elevates their rental properties above water. But the prevalence of this special circumstance is unknown and unlikely to add much to supply. However, pure investors who bought in recent years could provide fresh supply by unloading those properties to take advantage of higher prices. But the strength of rental yields relative to other investments implies high investor demand in the near term. The prospect of a mass dumping of properties by the investors is not in the cards this year.
A more direct means to increase supply is through new-home construction. Housing starts fell to historic lows for several years during the housing market crash. The initial decline was certainly justified to compensate for over-building during the bubble years.
However, my estimate suggests we have already overcompensated and are facing a housing shortage to the tune of 900,000 million. That is, cumulatively from 2001 to 2012, there were 15.7 million housing starts, while household formation along with the need to replace demolished units created demand for 16.8 million units (2001 was chosen for the beginning year since it was a non-eventful and very normal year for the housing market). Furthermore, if household formation is 1 million in 2013 along with 300,000 demolished/uninhabitable units and 100,000 in new demand for vacation homes this year — a reasonable and conservative assumption — then it will take 1.4 million housing starts just to meet the new demand this year without solving the previously accumulated shortage. This year’s consensus economist forecast on housing starts estimate is around 1 to 1.1 million. Consequently, the housing shortage is likely to worsen, sustaining robust price growth through the end of 2013.

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